How is money put into the economy? ie how is wealth created?

Most answers to questions like mine beg the question of where the money actually comes from, how it actually enters the economy, and to whom is it actually distributed when more money needs to come into the system. This ties into the creation of wealth. No matter how big the system, 3 people or 3 billion people, it seems impossible to create wealth without creating more money. Otherwise you are just shuffling money around, but not creating new wealth. For example: Suppose there are 3 people, who have basic needs met (food, shelter), living on a desert island. They each have 10 $1 bills. Joe creates widget from coconuts, and sells it to Tom for $5. Tom makes a necklace and sells it to Bill for $5, and Bill creates a cup and sells it to Joe for $5. Although three new products have been added to this small (but growing!) economy, there is no creation of wealth without the creation of more money. (assuming you can't barter)
So for the economy to grow - they must agree to increase the money supply to reflect this growth. Now I know the federal reserve prints money, but how do they get it into the economy?

Mar 24 2013:
your question is as important as overlooked. money is created by central banks, and they just talk about the total amount of money, M1, M2, etc. but exactly where the new money enters the economy, and where it is going would shine a light on a few things. they keep it secret, and for a reason.

however, your analysis about wealth, economics and money is the total opposite of the truth. wealth creation is completely possible with a fixed amount of money. it is even easier with a fixed amount of money. i recommend you to study some economics, for example with this introductory level reading: http://mises.org/document/2031 , available for free in electronic form.

Mar 24 2013:
basically anybody else :) the government would be the last entity i would trust, closely followed by the mob.

however, if your question is who to trust with supervising money, i have two approaches to that. the first is that we need many money-issuers, none of them with special privileges. trial-and-error selects the good money providers, just like in any other areas of business. the second approach would be science. we can build mathematic systems that allow everyone to check the total amount of money in circulation. one such concept is bitcoin, that has many problems and disadvantages, but it is actually working. i personally would like a somewhat different implementation, but nobody listens :)

Mar 24 2013:
i don't think we want to get deep into details. if i was a bank manager, and we were about to design a modern 21st century money, i would go for this: create virtual coins, that is, a money unit of a certain size, and a serial number. then create a public interface in which you can anonymously ask where each and every piece of money is at the moment. it would give you a location code which you can match with your secret code to find out if, according to the system, you are the legal owner or not. but the code would not be useful to find the owner if it is not you, just the fact that it is not you. using such a scheme would allow anyone to check if their coin is copied, preventing the bank from reissuing the same coin multiple times. unlike bitcoin, my system has an issuer and the issuer has access to my transactions (just like a bank today). on the other hand, the issuer also takes the responsibility to safeguard this information, while bitcoin puts that burden on me.

Mar 24 2013:
in bitcoin, every transaction is public. to maintain privacy, you can create as many "accounts" as you want, and there is no registration of any sort. but still, the transactions are public, so creating new money is not possible. nobody will take money from you if they don't see how that money got on your account. every piece of money can be traced back to its origin, simply by looking at the public database.

But what about the volume of money that is in play. I see where they state that there will only be 21 million bit coins issued and that they can be divided way down and they are going to issue fewer coins every year and stop at 21 million. But what determines the money supply? How does that work?

I see the advantages besides what you mention that the money supply is not dependent on any country, it would not be subject to manipulation as to value, it would not be subject to manipulation as to the money supply, it is not subject to printing money out of thin air in other words money with out labor associated with it, less chance of theft, more mobile.

Mar 26 2013:
depends on your definition of inflation and deflation. the neoclassical definition is change in general price level. fixed amount of money does not prevent some occasional change in the general price level. it prevents long-term in/deflation, since money is also subject to supply and demand, so its "price" in terms of stuff can not drift away from the equilibrium. the total amount of stuff exchanged compared to the total amount of money exchanged determines the price level.

in austrian theory, we don't believe in general price level, as it does not make sense. we define inflation as increase in money supply. using that definition, fixing the amount of money by definition prevents inflation, as it is the same thing. we acknowledge that the general tendency of prices is to fall with time. this means you can have more stuff if you earn the same amount. this is what we call progress, an increase in productivity. so it is sorta meaningful to say that deflation (price deflation to be precise) is the natural state of a functioning economy. but again, this is a very vague description of what happens. total spending does not shrink. the price of a certain item decreases.

So bit coin does not worry about the money supply. Inflation and deflation is basically irrelevant as there is no more bit coins brought into existence according to some arbitrary such as Bernanke or who ever was in charge in during the depression.

The thing that sticks in my mind is there was no inflation from 1776 until 1913. This Bitcoin idea might have legs. I'm going to do some more reading on it.

Mar 24 2013:
Thanks I will look it up. In the mean time I would love to hear more about how the money enters the economy. I read about the Bank of England and there it stated that money was created by loaning out money. The way I understand it is there is x amount of money - a loan is made for y amount, and so now the total money is x+y (+interest too). This is covered by a central entity (banks, government, aliens) ... Is this at all close?
Please keep your comments on topic - I am not so much interested in bit coin and that sounds like a good topic for a different thread. Thanks!

Mar 24 2013:
i'm not an expert on this, but here is what i figured out. two ways, one is direct money creation, and the other is money multiplication via fractional reserve banking.

direct: the central bank simply declares the money existing, and buys something from the market. usually what they buy is treasury bonds, but lately they buy other bonds, like mortgage based securities. the new money ends up in the hands of the issuer of the bond, that is either the government or some hedge fund issuing mortgage based CDO-s.

multiplication: since we have fractional reserve banking, banks lend more than they have. this multiplies the existing money stock to 10-20 times the original. the central bank created new money very soon gets multiplied, thus an additional supply of money floods the economy. it is also possible for legislators to ease the mandatory minimum reserves, say, from 10% to 7%, allowing banks to multiply some more. the new money appears in commercial banks, and they lend it out as they want (though they can not directly spend it).

for more information, look up "money multiplication". but expect to find information hard to believe. this is pretty much a journey deep into the rabbit hole. you will keep asking yourself, seriously? this is what they do? how is that reasonable? if any time you get the idea that fractional reserve is institutionalized crime, i will not blame you.

Mar 24 2013:
The only thing is that fractional banking is supposed to be a two way street. The reason Bernanke is buying mortgage back securities is to keep the banks assets from dipping below the required 10% and also keeping the price of housing artificially high which also keeps the bank's assets from dropping below the 10% requirement.

This is biggest case of crony capitalism in the history of the world. The big banks keep merrily going down the stream mean while small banks (small business's friend) are going extinct.

Mar 25 2013:
Really "wealth" and standard of living have nothing to do with money. Money is just a conduit. Your personal wealth is more related to how much time you need to work to meet your needs. (food,shelter etc) The less time you spend on meeting your needs the more time you have to meet your wants. By meeting your wants you become "wealthy". Therefore it is technology that creates this perceived wealth, as technology on the large scale reduces how much time you spend meeting your needs. The problem is that it's human nature for our wants to quickly adapt to the available time we have so we end up working just as long anyway.

Mar 25 2013:
It used to be the role of the central bank to create money, but today it is no longer so. Every commercial bank can, and in fact does, create money in quantities far exceeding their deposits. The result is that there is much much more money circulating in the economy than what the CB create.

To understand the whole process I strongly recommend the book by Jesus Huerta de Soto "Money, Bank Credit, and Economic Cycles".

banks kept expanding, but they were limited. enter the central bank as "conductor", and a nice simultaneous expansion can happen. central banks never for a second expanded the money supply without banks multiplying it. and cb's are still in charge, and commanding the ship.

unless, of course, you consider the king a central bank, and clipping money expansion. which is kind of true, but it was a different magnitude.

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